Verizon Earnings: Buyout Of Wireless Division In Focus As Competition Heats Up

Verizon (NYSE:VZ) is expected to release its Q3 2013 earnings results on Thursday, October 17th. During the earnings call, we will take a close look at the net subscriber additions to see how much of an impact the shutdown of Sprint’s iDEN network has had on the carrier amid an industry-wide saturation in wireless growth. While Verizon’s lead in LTE coverage should keep it in good stead, it faces heightened competition from smaller carriers Sprint and T-Mobile – both of which have emerged stronger following a flurry of recent M&A activity. Rising smartphone penetration and growing adoption of 4G LTE should however continue to drive Verizon’s data ARPU, which will become increasingly important to top-line growth as new subscribers become harder to find in the coming years. It is here that Verizon faces a significant threat from rivals who are aggressively marketing cheaper, unlimited and no-contract plans, which could push down industry-wide service prices in the long run.

Going into the earnings call, these downside risks to valuation are important for shareholders to consider given Verizon’s recent decision to buy out Vodafone’s stake in Verizon Wireless for $130 billion. Not only does the buyout valuation seem a little steep considering that not much will change at the carrier operationally, but the debt that the company has raised to finance the deal is also relatively costly which could further decrease any value that Verizon could generate from the deal. The markets have also moved likewise, sending the stock down by more than 10% in the past five months as bullish expectations ahead of the deal died out. It is currently trading close to our $48 price estimate.

The U.S. wireless market has become increasingly saturated with wireless connections having exceeded the population in mid-2011. This has made acquiring new subscribers, especially those that pay for the higher-margin data plans, very tough for the wireless carriers. Despite this, Verizon has banked on its better 4G LTE coverage to do much better than rivals on the postpaid front in recent quarters. Verizon is almost done with its initial LTE deployment, and is now looking to increase network density with LTE-Advanced and support new features such as VoLTE (Voice over LTE) ahead of rivals.

Last year, Verizon racked up as many as 5.1 million postpaid net adds versus AT&T’s 1.4 million for the full year. The trend has continued this year as well, with Verizon adding as many as 677,000 net postpaid subscribers during Q1 2013 – more than double AT&T’s postpaid net adds for the same quarter. In Q2 as well, the carrier added close to 950,000 postpaid subscribers despite AT&T’s aggressive marketing and promotional spending during the quarter. (See Behind In LTE Coverage AT&T Spends Big To Gain New Customers)

Competition heating up

However, Verizon is likely to have benefited in recent quarters from subscribers switching over from Sprint, which was accelerating the shutdown of its outdated iDEN network. The fact that rivals are fast catching up in terms of LTE coverage should also narrow the gap that Verizon has enjoyed for many quarters, and increase competitive pressure. While AT&T is on course to cover about 90% of its 3G coverage area with 4G LTE by the end of the year, Sprint is targeting LTE coverage of 200 million PoPs by the same time. Meanwhile, T-Mobile has raced to 200 million PoPs despite starting its build-out much later than the bigger rivals.

Increasing competition from the smaller carriers such as Sprint and T-Mobile could pressure Verizon’s margins going forward. Sprint, which recently received a cash infusion from Softbank and used it in acquiring Clearwire for its spectrum hoard, is putting its weight behind unlimited plans with its recently launched lifetime guarantee program. Meanwhile, T-Mobile has bolstered its LTE plans with the MetroPCS merger, and is looking to shake things up by promoting contract-less service plans as well as unlimited data plans of its own. With Verizon looking to move away from unlimited plans completely, competition from these value carriers could lead to subscriber loss as well as bring down prices.

Verizon Encourages Data Consumption

In order to counter this, Verizon is coming up with strategies to increase consumer loyalty and better hold on to its existing customer base. It recently launched a new program called Verizon EDGE which allows subscribers to upgrade their smartphones every six months so long as they have paid off 50% of the unsubsidized cost of the phone. Last year, the carrier launched Mobile Share data plans that allow subscribers to add more mobile devices to their service account. Subscribers who subscribe to these initiatives get further entrenched in the Verizon ecosystem, making it tougher to switch carriers. This is important because rising competition seems to be increasing Verizon’s churn numbers of late. Compared to 0.93% in Q2 2013, Verizon had a churn of 0.84% in the same period last year. A higher churn implies that a carrier is losing more of its existing subscribers, leading to higher costs as it looks to acquire new ones.

However, the increasing adoption of shared data plans will decrease the average revenue per device since the non-smartphone connected devices consume much less data. But Verizon’s revenues from each individual subscriber should also rise at the same time, as users connect more devices to its wireless network. It should also help shore up service margins due to low data consumption of these connected devices. Moreover, since the shared data plans are tiered, an increasing usage of Verizon’s high-speed LTE network will cause subscribers to jump to the higher tiers, enabling the carrier to better monetize its existing subscriber base.

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